How to approach the Stock Market – a lesson from Warren Buffet

This year the world’s most famous investor Warren Buffet did something unusual during his firm Berkshire Hathaway’s AGM.  He let the Apr 30th one-day event be telecast live over internet to anyone interested. I have taken one wonderful lesson delivered that day by Warren Buffet and rewritten it for the Indian market. It is here in 7 simple points.

  1. Lets say there are a 100 people sitting in front of us, and these 100 represent the entire Indian stock market shareholders, they own all the shares available. See Picture 1.  jainmatrix investments. audience
  2. Lets make a line in the center, and separate them out with the left half owning 50% of all shares and similarly the half on the right. The left half are passive investors. They do not trade shares much, just buy and hold. The ones on the right are active investors and traders. They invest through equity mutual funds, equity futures, buy and sell options, trade intraday, hedge funds, etc.
  3. The Indian Sensex has given 14.8% CAGR annual returns in 14 years since 2002. See Fig 2. jainmatrix investments, Sensex May 2016
  4. The people on the left are going to get the average returns of the Sensex, ie. 14.8 % CAGR over this entire period. They are passive, and so they will get the average returns. Tax on profits that are Long term capital gains (>365 days) on equity is zero.
  5. The ones on the right are also going to get an average of 14.8% over this entire period. However, their real returns will be much less due to tax, commissions, brokerage, AMC charges and success fees.
  6. Why is this? This is because:
    • The equity mutual funds are going to take away as much as 2.5% per year of AMC charges.
    • The traders in Futures and Options are essentially playing a +14.8% sum game, where the underlying equity is on average appreciating by 14.8%, and all the trading only declares some winners and some losers. The losses of the trading losers get transferred to the winners. Also, the intraday, momentum and swing traders too are in the same boat as F&O.
    • Trading is governed by an equation, Profits (by winners) + commissions + taxes = Losses (by losers). Of course if you are a good trader, you will get superior returns while another group will face the losses. But risks are higher here.
    • A lot of your money is eaten up by brokerage, taxes, AMC charges, fees and commissions.
  7. The lesson here is – become a passive long term investor and get the 14.8% long term average of returns. Spend your time on more useful things, and get good returns on investments.

Once again we thank the great investor for his simple but powerful messages.

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Warren Buffet enthusiasts may see the entire 7 hours of the AGM event on video on LINK.

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DISCLAIMER

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst (SEBI Registration No. INH200002747) under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com.

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